IRAs: Eligibility

March 4, 2013

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Who may establish an IRA?

Virtually any individual who wishes to do so may establish his or her own traditional individual retirement plan. To deduct contributions to such a plan once it is established and avoid tax penalties for excess contributions, an individual must have compensation (either earned income of an employee or self-employed person, or alimony), and must not have attained age 70½ during the taxable year for which the contribution is made.[1]

If an individual is an “active participant”, his or her deduction may be limited. Any individual who can make a rollover contribution may establish an individual retirement plan (or more than one plan) to receive it.[2]

To establish a Roth individual retirement plan, an individual (1) must have compensation (either earned income of an employee or self-employed person, or alimony), and (2) must not have adjusted gross income (in 2012) (a) of $183,000 or above in the case of a taxpayer filing a joint return, (b) of $125,000 or above in the case of a taxpayer filing a single or head-of-household return, or (c) of $10,000 or above in the case of a married individual filing separately. An individual who satisfies these requirements may establish and contribute to a Roth IRA even if he or she has attained age 70½.[3]

An estate may not make a contribution on behalf of the decedent.[4]

[1] .IRC Sec. 219.

[2] .Special Ruling 9-28-76.

[3] .IRC Secs. 219, 408A; IR-2011-103.

[4] .Let. Rul. 8439066.

May a person contribute to an IRA for a spouse?

A married individual may make contributions to a traditional individual retirement plan for a non-working spouse if (1) the non-working spouse and working spouse file a joint return for the taxable year, and (2) the amount of compensation (if any) includable in the non-working spouse’s gross income for the taxable year is less than the compensation includable in the working spouse’s gross income for the taxable year.[1] The deductibility of such contributions depends on whether the non-working spouse or working spouse is an “active participant” and on the married couple’s adjusted gross income.[2] Community property laws are disregarded for purposes of this deduction.[3]

A married individual may make contributions to a Roth individual retirement plan for a non-working spouse if (a) statements (1) and (2) above apply, and (b) the adjusted gross income of the married couple is less than the applicable limit.[4] The joint return rule implicitly requires that, except where one or both have died, the contributing individual and the contributing individual’s spouse have identical taxable years.[5]

An eligible individual may make contributions to a spousal plan even if the individual does not own or contribute to an individual retirement plan for himself or herself. Where plans are maintained for the contributing individual and his or her spouse, the plans may be separate plans or they may be sub-accounts of a single plan; a jointly-owned plan is not permitted. Nonetheless, each spouse may have a right of survivorship with respect to the sub-account of the other spouse.[6]

If the earner spouse dies during the taxable year, the surviving spouse may contribute to the spousal IRA if a joint return is filed for the year. No amount may be contributed to the IRA of a deceased spouse.[7]

The contributing individual must have been married to his or her spouse as of the last day of their tax year. An individual legally separated under a decree of divorce or separate maintenance is not married for these purposes.[8]

[1] .IRC Sec. 219(c)(2).

[2] .IRC Sec. 219(g).

[3] .IRC Sec. 219(f)(2).

[4] .IRC Secs. 219(c)(2), 408A(c)(3).

[5] .IRC Sec. 6013.

[6] .See General Explanation of the Tax Reform Act of 1976 reprinted in 1976-3 CB 442.

[7] .Let. Rul. 8527083.

[8] .IRC Sec. 6013(d)(2).

When must contributions to IRAs be made?

A contribution made on account of the tax year of the contributing individual may be deducted in that year. Contributions to existing or new plans may be made and new plans may be established as late as the time when the individual’s federal income tax return for the year is due (excluding extensions); with respect to traditional IRAs, contributions may be deducted for that tax year if the contribution is made on account of that year. This applies both to contributions to individual plans and contributions to spousal plans.[1] A postmark is evidence of the timeliness of the contribution.[2]

[1] .IRC Secs. 219(f)(3), 408A(c)(7).

[2] .Let. Ruls. 8633080, 8611090, 8536085.

How much may an individual contribute to a traditional IRA? How much may he or she deduct?

Contributions to traditional IRAs are limited at two levels. First, there is a limit on the amount of contributions that may be deducted for income tax purposes. Second, there is a limit with respect to the amount of total contributions that can be made, deductible and nondeductible.

Contributions to an individual retirement plan are not subject to the general limits on contributions and benefits of IRC Section 415. The source of the funds contributed to an IRA is not determinative as to eligibility or deductibility so long as the contributing individual has includable compensation at least equal to the amount of the contribution.[1]

Deductible Contributions

If an eligible individual contributes on his own behalf to a traditional IRA, he generally may deduct amounts contributed in cash up to the lesser of the “deductible amount” for the taxable year or 100% of compensation includable in his gross income for such year.[2]

The “deductible amount” is $5,000 for taxable years beginning in 2012. The $5,000 amount is indexed for inflation, and will be $5,500 for 2013.

The “deductible amount” is increased by $1,000 catch-up contributions for individuals who have attained age 50 before the close of the tax year.[3]

Employer contributions to a simplified employee pension and any amounts contributed to a SIMPLE IRA are subject to different limitations.

The overall maximum contribution limit is also equal to the “deductible amount”[4] $10,000 (or $20,000) for 2012, $11,000 in 2013. Contributions made to Roth IRAs for the taxable year reduce both deductible and overall contribution limits.

In taxable years beginning in 2007 through 2009, the “deductible amount” was increased by $3,000 for former employees of bankrupt companies with indicted executives (e.g., Enron), if the employer matched 50% or more of employee 401(k) contributions in the form of employer stock. For taxpayers age 50 or older, the enhanced catch-up contribution was available instead of the usual $1,000 catch-up provision.[5]

The actual maximum deduction allowed to an individual for a cash contribution to a traditional IRA for a non-working spouse for a taxable year is the lesser of (1) the “deductible amount” or (2) 100% of the non-working spouse’s includable compensation, plus 100% of the working spouse’s includable compensation minus (a) the amount of any IRA deduction taken by the working spouse for the year, and (b) the amount of any contribution made to a Roth IRA by the working spouse.[6]

Likewise, contributions to Roth IRAs for a non-working spouse reduce this limit.

While a husband and wife who file jointly and are both under age 50 are permitted a maximum deduction of up to $10,000 in 2012, the deduction for each spouse is computed separately.

The deduction for contributions made to individual and spousal plans may be reduced or eliminated if the individual or his spouse is an “active participant”. The amount of the reduction is the amount that bears the same ratio to the overall limit as the taxpayer’s adjusted gross income(AGI) in excess of an “applicable dollar amount” bears to $10,000 ($20,000 in the case of a joint return for taxable years beginning after 2006).[7]Applicable dollar amounts are indexed for inflation. Thus, the amount of the reduction is calculated as follows:

"deductible amount"

x

AGI - "applicable dollar amount"

In the case of a taxpayer who is an active participant and files a single or head-of-household return, the “applicable dollar amount” is $58,000 in 2012 and $59,000 in 2013.[8]

In the case of married taxpayers who file a joint return, where one or both spouses are active participants, the “applicable dollar amount” for a spouse who is an active participant is $92,000 for 2012 and $95,000 for 2013.[9]

In the case of married taxpayers who file a joint return, where only one is an active participant, the “applicable dollar amount” for the non-active participant spouse is $173,000 for 2012 and $183,000 for 2013. The denominator in the fraction remains at $10,000 (it does not increase to $20,000).[10]

In the case of a married individual filing a separate return where either spouse is an active participant, the “applicable dollar amount” is $0.[11]

Thus, for taxable years beginning in 2012, the IRA deduction limit is $0 for:

(1) individuals who are active participants and file a single or head-of-household return with AGI of $68,000 and above,

(2) married individuals who are active participants and file a joint return with AGI of $112,000 and above,

(3) married individuals where only one spouse is an active participant and file a joint return with AGI of $183,000 and above, and

(4) married individuals who are active participants or their spouses are active participants and file separately with AGI of $10,000 and above.

The amount of the reduction is rounded to the next lowest multiple of $10. Unless the individual’s deduction limit is reduced to zero, the IRC permits a minimum deduction of $200.[12]

For this purpose, AGI is calculated without regard to the exclusions for foreign earned income, qualified adoption expenses paid by the employer and interest on qualified United States savings bonds used to pay higher education expenses. Social security benefits includable in gross income under IRC Section 86 and losses or gains on passive investments under IRC Section 469 are taken into account. Also for this purpose, contributions to a traditional IRA are not deducted in determining AGI.[13]

The deduction is taken from gross income so that an individual who does not itemize his deductions may take advantage of the retirement savings deduction. IRC Sec. 62(a)(7). No deduction may be taken for a contribution on behalf of an individual who has attained age 70½ before the end of the tax year.[14] An individual over age 70½ may take a deduction for a contribution made on behalf of a spouse who is under age 70½. An excess contribution made in one year can be deducted in a subsequent year to the extent the excess is absorbed in the later year.

The cost of a disability waiver of premium feature in an individual retirement annuity is deductible under IRC Section 219, but where an individual contributes to an annuity for the benefit of himself and his non-employed spouse, the waiver of premium feature may only be allocated to the working spouse’s interest.[15]

No deduction is allowed for contributions to an IRA if the individual for whose benefit the IRA is maintained acquired that IRA by reason of the death of another individual after 1983. But this does not apply where the acquiring individual is the surviving spouse of the deceased individual.[16]

Nondeductible Contributions

Nondeductible contributions can also be made to a traditional IRA. The limit on nondeductible contributions is equal to the excess of the “deductible amount,” discussed above, over the actual maximum deduction.[17] Contributions made to Roth IRAs for the taxable year reduce this limit. This limit is not reduced because an individual’s AGI exceeds certain limits. A taxpayer may elect to treat contributions that would otherwise be deductible as nondeductible. Nondeductible contributions must be reported on the individual’s tax return and penalties apply if the required form is not filed or the amount of such contributions is overstated.

Planning Point: It is generally better to make nondeductible contributions to a Roth IRA rather than nondeductible contributions to a traditional IRA.

Endowment Contracts

Endowment contracts issued after November 6, 1978 do not qualify as individual retirement annuities; therefore, contributions to such contracts are not deductible.[18] Furthermore, in the case of contributions to an endowment contract individual retirement annuity issued before November 7, 1978, no deduction is allowed for contributions that are allocable to the purchase of life insurance protection. The amount allocable to life insurance protection is determined by multiplying the death benefit payable during the tax year less the cash value at the end of the year by the net premium cost. The nondeductible amount may be contributed to another funding medium and a deduction taken so that the maximum deduction may be used, but it may not be used to pay the premium for an annuity if the total premium on behalf of any one individual would then exceed the maximum annual contribution limit.

[1] .See Let. Rul. 8326163.

[2] .IRC Sec. 219(b)(1).

[3] .IRC Sec. 219(b)(5).

[4] .IRC Sec. 408(a)(1).

[5] .IRC Sec. 219(b)(5)(C).

[6] .IRC Sec. 219(c)(1).

[7] .IRC Sec. 219(g)(2).

[8] .IRC Sec. 219(g)(3)(B)(ii); Notice 2011-90.

[9] .IRC Sec. 219(g)(3)(B)(i); Notice 2011-90.

[10] .IRC Sec. 219(g)(7); Notice 2011-90.

[11] .IRC Sec. 219(g)(3)(B)(iii).

[12] .IRC Sec. 219(g)(2)(C).

[13] .IRC Sec. 219(g)(3)(A); See Treas. Reg. §1.408A-3, A-5.

[14] .IRC Sec. 219(d)(1).

[15] .Let. Rul. 7851087.

[16] .IRC Secs. 219(d)(4), 408(d)(3)(C)(ii).

[17] .IRC Sec. 408(o).

[18] .See Treas. Regs. §§1.408-4(f), 1.408-3(e)(1)(ix).

How much may an individual contribute to a Roth IRA?

An eligible individual may contribute cash to a Roth IRA on his own behalf up to the lesser of the maximum annual contribution limit (equal to the “deductible amount” under IRC Section 219(b)(5)(A)) or 100% of compensation includable in his gross income for the taxable year reduced by any contributions made to traditional IRAs for the taxable year on his own behalf.[1]

The maximum annual contribution limit is $5,000 for taxable years beginning in 2011 and 2012 and $5,500 in 2013. The $5,000 amount is indexed for inflation. The maximum annual contribution limit is increased by $1,000 for individuals who have attained age 50 before the close of the tax year.[2] SEPs and SIMPLE IRAs may not be designated as Roth IRAs, and contributions to a SEP or SIMPLE IRA will not affect the amount that an individual can contribute to a Roth IRA.[3] Qualified rollover contributions do not count towards this limit.[4] Roth IRA contributions are not deductible and can be made even after the individual turns age 70½.[5]

In taxable years beginning in 2007 through 2009, the maximum annual contribution limit was increased by $3,000 for former employees of bankrupt companies with indicted executives (e.g., Enron), if the employer matched 50% or more of employee 401(k) contributions in the form of employer stock. For taxpayers age 50 or older, the enhanced catch-up contribution was available instead of the usual $1,000 catch-up provision.[6]

An individual may contribute cash to a Roth IRA for a non-working spouse for a taxable year up to the maximum deductible limit (disregarding active participant restrictions) permitted with respect to traditional IRAs for such non-working spouse, reduced by any such contributions made to traditional IRAs for the taxable year on behalf of the non-working spouse.[7] Thus, a married couple (both spouses under age 50) may be permitted a maximum contribution of up to $10,000 for 2011 and 2012 ($5,000 for each spouse) and $11,000 in 2013.

The maximum contribution permitted to an individual Roth IRA or a spousal Roth IRA is reduced or eliminated for certain high-income taxpayers. The amount of the reduction is the amount that bears the same ratio to the overall limit as the taxpayer’s adjusted gross income (AGI) in excess of an “applicable dollar amount” bears to $15,000 ($10,000 in the case of a joint return).[8]. Thus, the amount of the reduction is calculated as follows:

maximum contribution

x

AGI - "applicable dollar amount" $15,000 ($10,000 if a joint return)

The “applicable dollar amount” in 2012 is (1) $110,000 in the case of an individual ($115,000 for 2013), (2) $173,000 ($178,000 in 2013) in the case of a married couple filing a joint return, and (3) $0 in the case of a married person filing separately.[9]

Thus in 2012, the Roth IRA contribution limit is $0 for (1) individuals with AGI of $125,000 and above ($127,000 in 2013, (2) married couples filing a joint return with AGI of $183,000 and above ($188,000 in 2013), and (3) a married individual filing separately with AGI of $10,000 and above. Except for married individuals filing separately, the “applicable dollar amount” is indexed for inflation. The amount of the reduction is rounded to the next lowest multiple of $10. Unless the individual’s contribution limit is reduced to zero, the IRC permits a minimum contribution of $200.[10]

For this purpose, AGI is calculated without regard to the exclusions for foreign earned income, qualified adoption expenses paid by the employer, and interest on qualified United States savings bonds used to pay higher education expenses. Social Security benefits includable in gross income under IRC Section 86 and losses or gains on passive investments under IRC Section 469 are taken into account. Also for this purpose, deductible contributions to a traditional IRA plan are not taken into account in determining AGI; amounts included in gross income as a result of a rollover or conversion from a traditional IRA to a Roth IRA are not taken into account for purposes of determining the maximum contribution limit for a Roth IRA.

[1] .IRC Sec. 408A(c)(2).

[2] .IRC Sec. 219(b)(5).

[3] .IRC Sec. 408A(f).

[4] .IRC Sec. 408A(c)(6).

[5] .IRC Secs. 408A(c)(1), 408A(c)(4).

[6] .IRC Sec. 219(b)(5)(C).

[7] .See IRC Secs. 408A(c)(2), 219(b)(1), 219(c).

[8] .IRC Sec. 408A(c)(3).

[9] .IR-2009-94.

[10] .IRC Sec. 408A(c)(3)(A).

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